All posts tagged New York Fed

There are no secrets in the bond markets. The New York Fed should know that.

A couple of hours Thursday afternoon in the markets for riskier mortgage-backed bonds show how hard it is for the Fed to be a player in sophisticated credit markets where information travels speedily and traders are skillful in finding an edge.

Thursday afternoon, the New York Fed tried to keep hush hush Goldman Sachs Group Inc.’s offer to buy a multibillion dollar parcel of risky mortgage bonds from its Maiden Lane II portfolio. But when word got out that the Fed had canvassed a few other dealers for competing bids, the news traveled fast that the U.S. central bank was back in the market with some of the toxic mortgage bonds it had acquired from the 2008 rescue of American International Group Inc.

The Federal Reserve Bank of New York is likely to resume selling the risky mortgage bonds taken on from American International Group at the height of the financial crisis as early as next week, according to investors who have been briefed by dealers.

The New York Fed is planning to sell about $7 billion in the subprime and other private-label mortgage bonds from the Maiden Lane II portfolio created to hold the assets, one of the investors said.

The sale would be the first since the Fed suspended the auctions last June. It stopped the process after dealers blamed cumulative sales of $10 billion for upsetting the balance of supply and demand, and knocking prices lower.

The Federal Reserve is among those feeling the pinch from the collapse of MF Global Holdings Ltd., which only eight months ago was added to the Fed’s list of 22 primary dealer banks.

MF Global’s spectacular downfall seems unlikely to pose a systemic financial risk to either the U.S. economy or the Fed, in sharp contrast to the fallout from Lehman Brothers in 2008. But it’s possible it will make the selection procedure tougher for primary dealers, an elite group of institutions with which the New York Fed conducts monetary policy and which are obligated to participate in U.S. Treasury debt auctions.

MF Global’s fortunes quickly went downhill over the past week amid concerns over its exposure to the euro zone’s sovereign debt. In this way, its travails underscore the potential contagion risks to the U.S. financial system via the primary dealer network. Besides MF Global, several primary dealers are owned by big European banks, including France’s BNP Paribas SA and Societe Generale SA, whose shares sold off in September due to concerns about their exposure to debts in Greece and other heavily indebted euro-zone sovereigns.

For anybody worried about the end of QE2 or feeling like the Fed is abandoning markets any time soon, take heart: Its ginormous bloated balance sheet will stay just as ginormous and bloated as ever, even when QE2 ends.

The New York Fed slipped out an announcement of its own just after the FOMC statement saying it had been commanded by Bernanke and Co. to take the cash from any expiring mortgage bonds and/or tulip-bulb futures and pump said cash right back into Treasurys, so as to keep the Fed’s balance sheet at a nice, steady $2.6 trillion.

This massive balance sheet, or “stock” of bonds, may be just as, if not more, important for the economy and markets than the “flow” of the Fed’s purchases of bonds. That’s probably the Fed’s theory, anyway, and it worked for them at the end of QE1.

Big hat-tip to Paul Kedrosky over at Infectious Greed for posting links to a New York Fed paper on the shadow banking system.

Quick refresher. The so-called shadow banking system is sort of a shorthand for the securitization market, in which loans were turned into bond-like securities. Some 40% of consumer lending worked like this before the financial crisis, according to The Journal’s David Wessel.

In this system, loans — such as mortgages — were packaged up and sold to investors, including other banks. Those sales permitted a vast expansion of credit, but they also tempted banks to be less careful in their lending. (Short version, if you get paid up front, who cares if the loan gets paid off to the creditors.)

And, because they kept or bought back many such loans in the form of asset-backed securities, the banks were highly exposed to these type of securities. When the value of those asset-backed securities began to fall, the foundations of our banks began to crumble and, voila!, the biggest financial crisis since the Great Depression and the worst recession in decades.

Now, you’d think that we’d want to avoid going back to a system that nearly sunk the economy. But in fact, many economists say reviving the “shadow banking” system is crucial to our ability to get credit moving healthily through the economy again.

In fact, as The Journal’s Ruth Simon pointed out in a story back in February, some types of asset-backed securities made a modest comeback in 2009, helped by support from the Federal Reserve’s Term Asset Backed Lending Facility, or TALF. Under TALF, the Fed makes low-interest loans to investors in certain securities and offers them protection against losses.

New issues of consumer asset-backed securities rose to $128 billion last year from $125 billion in 2008, but were down sharply from $217 billion in 2007, according to Barclays Capital. Such securities include those related to credit-card, auto, equipment and student debt.

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A rout in raw materials has helped drive down holdings in a Carlye Group firm’s flagship fund from about $2 billion to less than $50 million. The collapsing commodities market is spreading pain well beyond specialists to some of the heaviest hitters on Wall Street.